Volatility is one of the best phenomenon without which stock markets will loose its charm. It is the tendency of fluctuation of market indices over a period of time; more is the fluctuation, higher is the volatility. The ups and downs of stock prices is what that adds spice to the market behaviour. This see-sawing effect has its own implications, both good and bad. Good, because prudent investors taking advantage buy on dips and sell on highs for profit booking. On the flip side, greater volatility lowers investor’s confidence in the market prompting them to transfer their investment in less risky options due to unexpected market behaviour.
Having observed the past major events of volatility, one can realise the root cause as “unanticipated information” breaking out in the market. When this news stabilises, volatility vanishes because the uncertainty related dies out.
Few examples from recent past:
• Govt announced buying of shares/bonds of Indian companies through
participatory notes (PN).
• CRR and repo rates hike by RBI.
• Satyam fiasco and Lehman’s bankruptcy news.
• Stringent IPO regulations.
• US recession fear. Jan 21, 2008 saw biggest ever fall of 1408 points
due to volatility on account of US fears of recession.
Now the question arises how this uncertainty leads to such aftershocks in market.
Firstly, investments by FIIs have a major influence on movement of SENSEX which came into limelight during general elections of 2004. Owing to fear of reforms due to new government there was continued selling pressure by FIIs resulting in sharp decline in the index. Later on when the news regarding these reforms stabilised, FIIs started buying back the shares they sold earlier. Thus aiming at profit booking and balancing the portfolio, FIIs keep relocating their funds from time to time. For example if they find govt policies not in their favour, they would withdraw their investments from Indian markets and invest in some other market leading to sudden crash in index.
Secondly, Indian markets are sensitive to global markets. It has been observed that many times if NASDAQ closes high, SENSEX opens in green. So an unwanted news broke out in US may show its effects in Indian markets leading to intra-day volatility.
Thirdly, company specific news may cause volatile sessions in the market. From recent example of Satyam computers ltd, markets were highly volatile due to investor’s sentiment being in dilemma and anticipations about the future of company and related conglomerates.
Fourthly, Political news and news related to finance tend to affect market sentiment. Like RBI declaring CRR hikes, lowering interest rates prompt investor to relocate their investments accordingly. Likewise, news related to scams and frauds also create panic amongst investors making the markets volatile.
Volatility in acceptable limits is a sign of healthy markets as it leads to correction if there is overvaluation of prices. At the same time there is huge risk associated. The crux is that whatever you have in your portfolio of stocks, wind may start blowing against you anytime. So to play safe keep a margin to bear the volatility risk and don’t put all your eggs in same basket as the basic rule of portfolio management says.